Question

6. R and J form an LLC, which is treated as a partnership for income tax purposes. R transfers cash of $200 to the LLC in return for a 50% ownership interest. J transfers land with a tax basis of $140 and a fair market value of $200 in return for a 50% ownership interest in the LLC. Four years later the LLC sells the land that was contributed by J. The selling price was $230. How is the LLC's gain on the sale of the land allocated between R and J for income tax purposes (i.e., how much gain is allocated to R and how much gain is allocated to J)?

Answer 1

On the date of formation

As per section 721, J will not recognize any gain even though the land has been appreciated by $60. Instead, the gain is deferred and preserved by virtue of Sections 722 and 723, which provide that 1.) LLC takes a basis in the land equal to J's basis in the land, or $140; and 2.) J takes a tax basis in his LLC interest equal to his basis in the land, or $140. This way, if either 1.) LLC sells the land for its value of $200, or 2.) J sells his LLC interest for its value of $200, the $60 of gain inherent in the land will be recognized.

On sale date

As per section 704(c), Profit to the LLC = $230-$200 = $30. Which will be recognised to both R and J in equal ratio i.e $15 each.

And gain to J = $200- $140 = $60.

Gain to J= $60+ $15 = $75

Gain to R = $15